Thursday, April 28, 2011

Stagflation officially returned today with a nasty GDP report that showed only 1.8 percent real growth, but 3.8 percent for the consumer spending deflator. It’s a mini version of the 1970s: low growth, higher inflation.

Looked at another way, rising inflation is coexisting with high, near-9 percent unemployment. Keynesians argue this can’t happen. They believe strong growth and too many people working leads to high inflation. But they were blown out of the water way back in the ’70s. And their view is hitting another pothole right now.

Supply-siders know that inflation is a monetary problem. Growth is caused by low tax-rate incentives. And the combination of flat tax rates and sound money could produce strong growth with no inflation. Think 1980s and 1990s.

But that’s not what we have now.

The dollar is falling relentlessly and gold is soaring. These market indicators are correctly predicting higher inflation as the Fed creates more excess money than anybody knows what to do with.

Fed head Ben Bernanke yesterday told us that low Q1 growth and high inflation will be “transitory.” How does he know this? Gold has gone up $40 since he started talking at his Wednesday press conference. It’s now at $1,536 an ounce. And the greenback keeps falling. Transitory? Actually, it looks like the whole QE2 pump-priming hasn’t stimulated economic growth, but has stimulated inflation.

And while the Bush tax cuts were extended last December, the sharp dollar decline and the resulting inflation have neutralized the positive effects of continued lower tax rates.

Once again I note the supply-side model is low tax rates and a stable dollar (backed by gold). But low tax rates and collapsing dollar is no good. Neither is overspending and over-borrowing. Nor is the new round of Obama-based tax-hike threats.

And the Treasury Department hasn’t lifted a finger to support the dollar. So the Bernanke Buck keeps tumbling. The White House won’t come to the table for a budget deal. And the economy is showing signs of stagflation.

Thank heavens for profits. Business productivity and profits in the private sector are the saving grace of this whole story. And let me dream that government will just leave businesses alone, and let them continue to support the economy and the stock market.

Because if stagflation is not transitory, businesses may have to tighten their belts once again.

ARE WE STEPPING IN STAGFLATION? - John Lonski, Moody's Capital Markets Research Group Chief Economist - David Goldman, Former Head of Fixed Income Research at Bank of America; Senior Editor First Things Magazine -

Wednesday, April 27, 2011

Fed head Ben Bernanke, at his first-ever news conference on Wednesday, slammed the door shut on any new QE3 pump-priming. The $600 billion QE2 program to purchase bonds will end on target at the end of June, and that will be that. Mr. Bernanke also suggested that the Fed’s “extended period” for the near-zero federal funds target rate could end in a couple of meetings. Perhaps these announcements suggest a bit-less-easy monetary policy. Perhaps.

But Mr. Bernanke had no defense of the sinking dollar, or the inflation it brings, or the drop in middle-class living standards it causes. So it’s little surprise that gold prices surged $24 to $1,526 during the Fed chairman’s press conference. Silver jumped sharply as well. The markets clearly don’t see any King Dollar shift by the Fed.

Mr. Bernanke just doesn’t get that inflation-sensitive market-price indicators -- like rising gold, oil, and commodity indexes, and the falling dollar exchange rate -- are trying to signal higher future inflation. Instead of listening to markets, he is determined to fight them. This is a losing battle. Instead of a market-price rule (anchored by gold) we have some sort of Bernanke fine-tuning rule. It’s not working.

While Mr. Bernanke slightly downgraded the central bank’s economic outlook and slightly upgraded its inflation concern, the Fed still holds out “hope” that the sluggish 2 percent first-quarter GDP will give way to 3 percent or more growth later this year, and that the commodity-based bulge of inflation will come back down as commodity prices somehow sink. This seems to be a triumph of hope over experience.

With the CPI running about 6 percent annually in the first quarter, the real inflation-adjusted fed funds rate is deeply negative. Under similar circumstances in Europe, Jean-Claude Trichet raised the ECB target rate by a quarter of a percent last month. By that benchmark and others, the Fed’s so-called return to normalcy is way behind the curve.

Look, the economic emergency dating back to the fall of 2008 has long been over. And the alleged deflation threat has completely dropped off the radar screen. In the absence of these risks, the Fed’s ongoing emergency policies -- including the zero target rate and the $600 billion QE2 -- make no sense at all and should be withdrawn.

I recall how President Reagan often argued in the 1980s not simply that a strong dollar was in the nation’s interest, but that a great country, by necessity, needs a strong and reliable currency. Link to gold -- that was Reagan’s argument. Paul Volcker and then Alan Greenspan (during the first three of his four Fed terms) essentially agreed with Reagan. The 20-year collapse of gold prices that ensued was associated with a remarkable non-inflationary prosperity and a huge stock market rally that generated unbelievable volumes of new wealth for investors and entrepreneurs.

Today, this hard-money thinking is nowhere to be found in official Washington. Yes, the Fed can produce new money. But no, it can’t produce new jobs and growth in any permanent sense. What does? Limited spending, flat tax rates, minimal regulation, and stable money.

Now where’s the next great American leader to revive and restore this pro-growth model?

IS THE DEFENSE DEPARTMENT UNDER ASSAULT? WHAT'S THE COST? DOES THIS MEAN DEFENSE BUDGET WILL BE SLASHED? WHAT'S IT MEAN IN TERMS OF KEEPING U.S. MILITARY READY? PETREAUS TO RUN AFGHANISTAN FROM CIA? - Col. Jack Jacobs, U.S. Army (Ret.); NBC Military Analyst - Howard Rubel, Jefferies and Co. Aerospace/Defense Analyst - Gen. Barry McCaffery, NBC Military Analyst; U.S. Army (Ret.); McCaffrey Associates Pres.

Tuesday, April 26, 2011

When oil prices blew sky high in 2008, ExxonMobil paid $36.5 billion in income taxes, $34.5 billion in sales taxes, and $45 billion in other taxes, for a total of $116.2 billion in taxes paid and collected in 2008. That’s according to Mark Perry at the Carpe Diem blog.

Exxon will report earnings later this week. And while oil prices aren’t quite as high today as they were three years ago, it’s all a bit like 2008.

I read somewhere that either Exxon or the whole oil industry pays more in taxes than the bottom 50 percent of the whole income-tax system. So while president Obama is out there ragging on oil companies to remove so-called tax subsidies, it’s odd that he doesn’t mention how much in taxes the energy firms actually pay to Uncle Sam.

There’s a laundry list of tax credits that go to oil, both large and small firms. Basically, these tax credits allow for the expensing of high-risk investment. That’s what this is about.

Of course, if you really wanted to stop expensive subsidies, you’d kill the ethanol subsidies that have a big carbon footprint and drive corn and wheat prices sky high. But the liberal-left progressives hate oil and gas companies, period. That’s really what all this is about.

Ironically, besides the usual plea for wind, solar, and biofuels — which amount to virtually nothing in terms of our energy use — the president does include natural gas. But natural gas is produced by oil and gas companies. And you have to drill for it. Therefore, oil expenses in the whole drilling process — including leases, permits, geology research, and dry holes, and then drilling, producing, lifting, and ultimately refining for sale — should be 100 percent expensed.

So it would be great if the president understood that you have to drill for natural gas. It also would be great if the president and his pals, instead of harping on a measly $4 billion a year in so-called subsidies (compare that with a $1.5 trillion deficit), focused on real pro-growth corporate-tax reform that drops the rates and includes permanent 100 percent expensing.

That’s pro growth. That’s tax reform. That will create more oil, more natural gas, and more gasoline. That would probably stabilize prices, assuming the Fed doesn’t totally destroy the dollar. That would generate millions of new jobs and lower unemployment. And that would be a good policy.

Wednesday, April 20, 2011

As I’ve written many times before, profits are the mother's milk of stocks, and for that matter, business and the entire economy. And what we saw today in this big market rally was the return of earnings to the center stage.

Not just Intel's numbers, and not just Apple after-the-bell, but industrial companies like Honeywell and United Technologies and consumer companies as well. Ultimately, the recovery in profits over the past two years has been the backbone of the stock market’s big rise.

Here's another point on profits: Don't overlook the important role productivity plays in American business. It's running a solid 2.5 percent, and even higher in manufacturing and hard goods.

Look, American companies are very efficient. They are not in decline.

In fact, firms from all over the world are borrowing successful methods from American business and producing much more than folks think. And that's why the global economy is stronger than many people probably think.

Of course, I’d like to give American businesses greater incentives to create more jobs here at home. But we are still—in the U.S.—the best in business in the world. Washington needs to keep it that way with more free market policies, rather than suffocating government tax and regulate policies.

Another point on today's rally: the falling dollar. I hate it. I’m a King Dollar man. Link to gold.

But let me go out on a limb here: if we get a debt ceiling increase with enforceable spending limits, and if the ultra-easy, Bernanke Fed finally ends its pump-priming QE2 overprinting of new dollars, then we could see a dollar stabilization or even rally before long.

I hope so. I don’t want to lose our status as the world's reserve currency.

So, might a stronger-than-expected dollar hurt stocks? In the short run, a brief correction is certainly possible. So yes. But in the long run, healthy and profitable business is always the key to the stock market.

Tuesday, April 19, 2011

Treasury man Tim Geithner was optimistic today about getting a deal on the budget deficit and raising the debt ceiling. In particular, he was confident that in the next few months a compromise would lock in some clear targets for deficit reduction, with a credible enforcement mechanism. He believes the debt-ceiling increase would not be rejected by Congress and that the congressional deal would also put in place deficit targets.

But the problem with the deficit, and for that matter the growing debt, is that we spend too much and grow the economy too little.

Mr. Geithner may run up against a brick wall on deficit targets. The House Republicans want spending limitations, not deficit targets. It’s not a simple semantic issue. A so-called deficit target leaves open the probability of a big tax hike. In fact, as we know, the president’s budget has roughly $1.5 trillion in new taxes. That includes repealing the Bush tax cuts for the top 2 percent of earners and investors, as well as removing many of their tax deductions. As much as half the president’s deficit-reduction plan is absorbed by higher taxes.

This is why the GOP wants a spending-limitation mechanism. As a share of the economy, spending would be gradually ramped down from 25 percent to around 20 percent. Targets would be set each year. And if those targets are missed, budget -cutting penalties would kick in and the excess funds would be sequestered across the board. This is designed primarily for the non-entitlement portion of the budget.

So you can see the difference in the two approaches. Nobody, myself included, wants to see any default on the servicing of U.S. debt, including interest-expense-payment default. But in the next few months there ought to be plenty of time to work out a compromise with new spending rules.

The differences here are of course philosophical — bigger government versus smaller government. But in economic terms, you could conceivably force a debt-reduction target in the short run that would raise taxes so much that economic growth would be damaged in the longer run. And that would create a bigger deficit.

On the other hand, lower spending as a share of GDP frees up resources to grow the private sector in the market economy. Couple that with pro-growth tax reform to flatten the rates and broaden the base, and you’ll get a more efficient economy with an even lower budget deficit.

Monday, April 18, 2011

There’s a lot of talk right now about U.S. credit downgrades and whether we can possibly get a Washington budget deal that actually controls spending and borrowing.

Stocks are worried. And they should be. But there is an additional danger lurking out there that investors need to be paying close attention to: the end of QE2.

In the long run, I think it would be great if the Fed finally stopped pumping all this inflationary money into the system. But shorter term, my advice to you is "caveat emptor"-- investors beware.

The so-called “risk-on” trade, which means the cheaper dollar alongside booming stocks and commodities, has been a staple of this market going back to Fed head Ben Bernanke's first QE2 announcement late last August.

Gold, silver, energy and oil, copper and raw materials, foods, have all obviously soared on this quantitative easing. And so have the exact same sectors in the stock markets.

But the risk-on trade may soon be replaced by the risk-off trade.

Keep an eye on next Wednesday, April 27th. That’s when the Fed releases its minutes. There may very well be an "end QE2 signal" and that could mean the beleaguered dollar -- at least temporarily -- will go up, not down. It might also mean that commodity, energy, and even industrial stocks could go down, not up.

Already, I notice the best performers have been defensive shares, like health care and utilities, not the cyclical economic growth groups.

There may be a correction in the cards as the Bernanke Fed’s ultra-easy money comes to an end. And that, investors, is what you should be looking out for right now.

Wednesday, April 13, 2011

We thought tax reform meant lowering rates and broadening the base by eliminating or cutting back on various deductions, credits, and loopholes. That’s what the Bowles-Simpson commission proposed. That’s what Paul Ryan and David Camp are working on. And that’s the pro-growth model.

But President Obama unveiled a much different tax-reform vision in his much-anticipated debt speech on Wednesday. He would raise tax rates on upper-income earners and small businesses. He also would eliminate deductions and credits, or so called “tax expenditures.” The president referred to these tax-expenditure reductions as “spending cuts.” In his context, they most certainly are not. They are more tax hikes.

Basically, the president is giving successful earners and small-business filers a double tax hike. That’s what it really is.

Of course, the president’s formula of estimating higher revenues to lower the deficit is completely wrong. The reality is that higher tax rates will slow the economy, inhibit new start-up companies, penalize investors, and may very well lose revenues and increase the deficit.

In the latter part of his speech the president did mention some kind of middle-class and corporate tax reform. But he gave no specifics.

He also touted $750 billion in discretionary spending cuts, but again without any details. Most of that amount probably comes from the recent continuing resolution to avoid a budget shutdown. Since Obama is extrapolating out twelve years, who knows how this is scored.

On the entitlement front, Obama rejected Paul Ryan’s consumer-choice and competition approach to Medicare reform. Instead, he invoked the Obamacare central-planning agency called the Independent Payment Advisory Board, which is supposed to make reductions in Medicare. Medicare itself would exercise more price controls on prescription drugs, rolling back the consumer choice and competition established under George W. Bush.

In total, President Obama is claiming $4 trillion in deficit reduction over twelve years. But we’ll never see it. Interest expense savings is supposed to make up $1 trillion of that amount, while the rest will somehow come from a concoction of fewer tax deductions, higher tax rates, and $400 billion in defense-spending cuts.

In effect, the president has moved to the left. He has embraced the Democrats’ so called progressive caucus in the House by slashing defense and jacking up taxes, all while offering no serious entitlement reform. (Hat tip to Jimmy Pethokoukis for nailing this earlier in the week.)

My final point is this: President Obama’s harsh-rhetoric rejection of the Ryan budget and his new (presidential) campaign to raise taxes on the rich sets up a huge confrontation with House Republicans on the eve of the hugely important debt-limit expiration.

Sometime in mid to late May, the debt ceiling to allow the government to borrow more money is going to run out. The Treasury can move money inside government accounts to forestall a debt breakdown for another couple of months. But the potential for a major political conflict on the eve of this process sets up the worst possible outcome: Failure of the U.S. to pay the interest on its own debt.

This is unnerving to financial markets. Instead of compromise, the president decided to seek confrontation.

A supercharged Mitt Romney in very strong form told me last night on CNBC that President Obama is completely “incompetent” on job creation and the economy. I asked him whose head should roll: Bernanke? Geithner? EPA’s Jackson? Without missing a beat the former Governor said—Obama’s head must roll.

On his controversial RomneyCare, he moved further away from the Massachusetts plan he sponsored. While he wouldn’t completely disavow the mandate, his tone and emphasis has shifted away from defending his plan. Nationally, he would immediately waive ObamaCare for all fifty states as the first immediate step for total repeal.

Governor Romney welcomed Donald Trump into the Republican presidential race. But he pointedly dissed Trump by saying Obama has passed the citizenship and birth certificate test.

Tuesday, April 12, 2011

This pessimism is rooted in themes I’ve been discussing for weeks and weeks—namely, lower profit margins from spiking energy, food, and raw material prices; supply-chain disruptions from the Japanese disaster that cuts into top line sales revenue; and gasoline price hikes depressing the consumer.

It’s all there and it's all a problem.

But, I do not believe there's an end of the world stock market trade here. Corrections come and go. We may be correcting.

However, the level of corporate profits, which are the mother's milk of stocks, is rising—perhaps 12 percent in the first quarter and something like that for the rest of the year.

The Fed is easy. And it will remain accommodative even after QE2 ends.

Now I do worry a lot about the inflation from the depreciating dollar. And import prices are rising now 9.7-percent for the year ending March. This is bad.

But on the positive side, global growth, especially in Asia, is solid. Railroad shipping volume is picking up steam. The jobs picture is improving. Manufacturing is strong. Business CEO and CFO surveys are optimistic. Credit markets and financial conditions have recovered.

Even the Washington, DC story is improving with new budget cuts and a potential compromise on a higher debt ceiling tied to spending reforms. And for now, tax rates are low.

All I want to say is this is not the end of the world. There are pluses and minuses. It's not a one-sided bear trade. I still believe in longer-term optimism.

White House press secretary Jay Carney said Republicans should not “play chicken with the economy.” The administration wants a prompt vote to raise the federal debt ceiling quickly. Carney went on to say, “The consequences of not raising the debt ceiling would be Armageddon-like in terms of the economy.”

But then again, if the federal debt limit keeps getting raised without any real new spending-limitation rules, Armageddon for the economy may come just as quickly. The problem with the rising debt burden is too much spending and too little growth. A spending-limitation of 20 percent to GDP would go a long way toward fixing the debt-bomb problem.

A number of Republicans are proposing such a limit, with real teeth to force automatic spending cuts across the board if the limit is violated. House and Senate Republicans will not agree to an increase in the debt limit without these kinds of serious spending reforms. As they say, it’s time to stop maxing out the credit card. There has to be some discipline in the fiscal system.

The current $14.3 trillion debt ceiling will run up against the wall sometime early this summer. As of the end of March, there’s a $76.1 billion borrowing limit left. Treasury man Tim Geithner says all measures to postpone a U.S. default on its obligations will end approximately July 8, 2011. At that point, government payments -- including interest on the Treasury debt -- would be stopped.

So the message for investors is tighten your seatbelts. The hard-driving politics of spending reform and debt limits will go down to the wire. At virtually the same time, the Fed will probably have ended QE2. So debt-default worries, along with possible inflation fears, could drive up interest rates and hurt the stock market as well.

But let’s not forget, the debt bomb is coming due, sooner or later. Better for Washington to cancel its summer vacation and put some serious disciplined limits on federal spending and borrowing. Take away Washington’s credit card.

Friday, April 08, 2011

Washington shutdown fears are sinking the U.S. dollar, according to some news reports. Surely there’s something to this, as investor confusion rises and confidence falls, and as Washington seems to be gridlocked over a few billion dollars.

Frankly, the GOP could easily declare victory and accept a $35 billion to $40 billion spending cut for the final strokes of the 2011 continuing resolution. This kind of deal would move the domestic discretionary baseline back towards 2008. No mean feat.

Over ten years, estimates range above $400 billion in real cuts in the level of those domestic programs. Considering where the process started — with the failure of the Democrats to propose a budget, and then the early Democratic response of only $5 billion in CR budget cuts — the GOP has come a long way in the absolute right direction.

So from here the GOP could move from billions in CR cuts to trillions in cuts in the Paul Ryan budget.

Yet however this works out, the principal cause of the declining dollar is not a threatened government shutdown and the debt worries behind it. It’s the excess money creation of the Fed, which is falling further and further behind the international curve of currency stability.

While Bernanke & Co. have increased the adjusted monetary base by about $500 billion since late December, other central banks have been tightening policy in order to stabilize their currencies and fight inflation. The ECB went for a quarter-point hike this week. And the euro is trading strong at 1.44 to the dollar.

Over the past year or so, Canada and Australia have raised rates several times. Their currencies are soaring. China and other Asian countries also have been gradually tightening policy. In all these cases, foreign central banks are rejecting the over-supply of dollars coming their way.

So, by the way, are Middle East oil producers, according to CNBC reporting. As U.S. crude-oil prices have shot up 30 percent since mid-February, the Saudis and others have been selling much of the dollar proceeds from the high-priced oil sales.

It just seems like nobody wants dollars. That’s because there’s too many of them. And a lot of the excess dollar flow is finding its way into commodities — including oil, but most especially gold and silver, which are traditional monetary substitutes. Right now gold is cruising towards $1,500 an ounce. Silver has passed $40. Crude oil is over $112, and European crude is back to $126.

In a recent survey by Reuters, one-in-five traders said they expect Brent oil to hit $150 this year. Gasoline prices in the states continue to surge, with the AAA national average retail price moving to $3.74. In almost ten states, the gallon price is hovering around $4.

Nobody knows where the energy tipping point is for the economy and stocks. And by and large, the market has held up rather well. But these spiking prices are surely a threat.

There’s no question that the potential U.S. debt bomb from overspending is a backdrop fear for investors. Long-run, that bomb could be just as much a dollar destroyer as the over-easy Fed. And perhaps the debt bomb and cheap money are ultimately two sides of the same coin.

But right now another $35 billion in spending cuts that eventually will come out of the shutdown debate is at least a small part of the solution. The problem remains a stubborn Fed, with its head in the sand, and with its failure to see world monetary and commodity threats closing in all around it.

Wednesday, April 06, 2011

Of all the discussion about Paul Ryan’s big-bang budget plan, the element I like best was caught in this Wall Street Journal op-ed title: “The GOP Path to Prosperity.” In other words, it’s a growth budget. It has plenty of spending cuts, but it also has significant pro-growth tax reform.

Obsessing over the debt is not by itself a policy. Advancing the economy and setting the stage for more job creation is a policy. Mr. Ryan kept an important dose of Ronald Reagan in both the spirit and reality of his plan. Limited government, lower tax rates, and deregulation (of energy) will all promote the path to prosperity.

The other big-picture thought is that the fiscal-policy ball is moving in the right direction. Most of what is being proposed faces a rocky political future. But the direction is unmistakable: less government, lower taxes.

This really started back in December with the extension of the Bush tax cuts and the withdrawal of the trillion-dollar omnibus continuing-resolution spending bill. It continues into the new year with new CRs. Whether Speaker Boehner gets $30 billion or $40 billion in cuts, the direction is clear: lower spending.

Just before the election, John Boehner told us he would stop the bad stuff. Looks like he has. And now Mr. Ryan keeps the drumbeat going with a 2012 budget that would cut $179 billion from the president’s budget baseline. In 2013, Ryan would take down over $220 billion. Over ten years, Ryan would lop off $6 trillion. The key point is not the actual numbers, but the direction of the numbers. Spending is coming down.

Ryan included the thinking of Dave Camp (the Ways and Means chair) on tax reform, which is a 25 percent top rate for individuals and businesses with a full-scale reduction in all the tax-credit, K Street, flotsam-and-jetsam loopholes. That’s very pro-growth.

Ryan also includes deregulation of energy for drill, drill, drill — another big growth and jobs measure.

The health-care entitlement picture is going to be very muddled, and the outcome is impossible to figure. So I’ll leave that aside for a moment. The only thing Ryan neglected to do was highlight the need for stable money to stop the damaging Fed rollercoaster. But with so much on his plate, I can understand that omission for now.

Ryan basically stole the budget bacon from President Obama, who should have put this kind of plan in his State of the Union. He didn’t. And now he’s got to play catch-up. The Senate Democrats are utterly hopeless. But the public mood is still where it was last fall: less government spending and borrowing. Ryan delivers on that and then some with his tax-cut growth booster.

The cause of the debt bomb is too much spending and too little growth. Ryan attacks this with new spending rules and tough policy decisions. He also provides the new flat-tax reform incentives to grow the economy.

So if we look at the debt bomb as a share of GDP, what will happen — if Ryan prevails even modestly — is the numerator of debt will steady while the denominator of growth is unleashed.

We will be fine. I can almost hear Paul Ryan saying, “I will not allow America to become Greece.” Amen.

LIGHTS OUT IN WASHINGTON?-CNBC chief Washington correspondent John Harwood reports.

GOLD VAULTS TO RECORD HIGHS....HOW HIGH WILL IT GO & WHY & WHEN WILL THE PARTY END?- David Goldman, Former Head of Fixed Income Research at Bank of America - Jon Najarian, Co-Founder, OptionMonster.com; Fast Money Contributor

TRUTH SQUADING THE CONSEQUENCES OF A GOVERNMENT SHUTDOWN- CNBC's Hampton Pearson reports.

"THE TIME FOR COMPREHENSIVE TAX REFORM HAS COME"- Rep. Dave Camp (R) MI; Ways & Means Chmn- James Baker, former White House chief of Staff and Treasury Secretary

Tuesday, April 05, 2011

Of all the discussion about Paul Ryan’s big-bang budget plan, the element I like best was caught in this Wall Street Journal op-ed title: “The GOP Path to Prosperity.” In other words, it’s a growth budget. It has plenty of spending cuts, but it also has significant pro-growth tax reform.

Obsessing over the debt is not by itself a policy. Advancing the economy and setting the stage for more job creation is a policy. Mr. Ryan kept an important dose of Ronald Reagan in both the spirit and reality of his plan. Limited government, lower tax rates, and deregulation (of energy) will all promote the path to prosperity.

The other big-picture thought is that the fiscal-policy ball is moving in the right direction. Most of what is being proposed faces a rocky political future. But the direction is unmistakable: less government, lower taxes.

This really started back in December with the extension of the Bush tax cuts and the withdrawal of the trillion-dollar omnibus continuing-resolution spending bill. It continues into the new year with new CRs. Whether Speaker Boehner gets $30 billion or $40 billion in cuts, the direction is clear: lower spending.

Just before the election, John Boehner told us he would stop the bad stuff. Looks like he has. And now Mr. Ryan keeps the drumbeat going with a 2012 budget that would cut $179 billion from the president’s budget baseline. In 2013, Ryan would take down over $220 billion. Again, the direction is more important than the actual number.

Ryan included the thinking of Dave Camp (the Ways and Means chair) on tax reform, which is a 25 percent top rate for individuals and businesses with a full-scale reduction in all the tax-credit, K Street, flotsam-and-jetsam loopholes. That’s very pro-growth.

Ryan also includes deregulation of energy for drill, drill, drill — another big growth and jobs measure.

The health-care entitlement picture is going to be very muddled, and the outcome is impossible to figure. So I’ll leave that aside for a moment. The only thing Ryan neglected to do was highlight the need for stable money to stop the damaging Fed rollercoaster. But with so much on his plate, I can understand that omission for now.

Ryan basically stole the bacon from President Obama, who should have put this kind of plan in his State of the Union. He didn’t. And now he’s got to play catch-up, although the Senate Democrats are utterly hopeless. The public mood is still where it was last fall: less government spending and borrowing. Ryan delivers on that and then some with his tax-cut growth booster.

I’m not so worried about deficits and debt, as long as I know the spending baseline has new discipline and sufficient incentives exist to grow the economy. In some sense I hear Paul Ryan saying, “I will not allow America to become Greece.”

Friday, April 01, 2011

Did the big March jobs report put President Obama back on the road to reelection? If so, he can thank the GOP, whose tax cuts saved him from himself.

You could hear cheering all the way from the West Wing when the Labor Department showed a 216,000 gain in nonfarm payrolls, the biggest number in quite some time. Plus, the unemployment rate continued its decline to 8.8 percent. Not so long ago it was nearly 10 percent.

Corporate payrolls have now increased by 478,000 for the first three months of the year. Over the past three months, the average payroll gain has been 159,000, which is more than twice the monthly gain in 2010. If payrolls stay on track, that would mean nearly 2 million jobs created in 2011.

So sure, the White House must be very happy. In fact, everybody should be happy at an improving jobs picture.

But here’s the sublime irony. The wake-up in job creation is a function of Republican policy. After all, for two years the Obama Democrats spent themselves into oblivion, with over $1 trillion of so-called big-government stimulus. Didn’t work. By the end of last year, that failed stimulus wore off, and it was replaced by Republican tax cuts.

Remember that in mid-December, after his election shellacking, President Obama signed a deal that extended the Bush tax rates across the board. The top marginal rate stayed at 35 percent. Investment tax rates for cap-gains and dividends held at 15 percent. Most business people I know — folks who work in both large and small companies — welcomed the tax-rate freeze as a sign that maybe the war against growth, capital formation, and small business was either coming to an end or at least a two-year truce.

So, presto, the jobs numbers start jumping in the new low-tax year.

The most important tell-tale sign for jobs is the household employment survey, which includes most of the nation’s small businesses. It’s the survey that signals real turning points in job creation since it’s the small-business owner-operators who are most sensitive to changing marginal tax rates.

And clearly, tax incentives matter: For March, the household survey jumped 291,000. Year-to-date, household employment is up 658,000, and is on track for a 2.6 million gain for the year. This small-business jobs push is also what’s driving down the unemployment rate.

So it looks like Republican tax cuts have saved Obama from himself. And the GOP ought to stay on this tax-cutting path as they move toward limiting the budget. Full-throated flat-tax reform to lower marginal rates and broaden the base will create brand new incentives for growth and jobs.

The GOP also should be on the warpath for full-fledged corporate-tax-rate reduction. Get rid of the GE loopholes and knock the rate down to 15 percent. As they continue to advance on the spending-cut front, Republicans should balance out their message with strong pro-growth tax cuts.

That said, there is a big glitch in the economic and jobs story: It’s called inflation — especially oil- and gas-price increases, but also food-price hikes. And there are new signs of price increases for all manner of goods and services. Inflation is the economy’s Achilles ’ heel.

Crude oil just hit $108. Nationwide gasoline is now around $3.60.The CEO of Wal-Mart warns of major retail price increases, saying they are already showing up in dairy and cotton products, with more coming in transportation. Consumer product companies are raising prices. Hershey’s chocolate is raising prices. And while the ISM manufacturing report in March showed strong business conditions, 85 percent of survey respondents reported higher prices.

And the energy-price hikes are already depressing consumer incomes. Average hourly earnings in the jobs report have been flat for the last two months, even while the consumer price index has been steaming ahead at a 5.6 percent annual rate over the past three months. In fact, measured over three-month periods, a real-wage income proxy, which includes average hourly earnings and hours worked adjusted for the CPI, has actually declined four consecutive months. This is a warning that inflation is taking its toll.

Both Democrats and Republicans in Washington must understand that over-easy Fed policy has depressed the dollar and reignited inflation. Politicians in both parties should be fighting for stable money. On the energy front, deregulation to unleash drill, drill, drill is more important now than ever.

So while there’s good news on jobs, the battle for the economy has not yet been won. And the November 2012 election is still a long way away.

Last night I had the pleasure of speaking with James Grant, the legendary founder of Grant's Interest Rate Observer. He called the bubble in the 2000s. Right now he's worried about a big jump in inflation. He thinks interest rates are totally unprepared for it. His solution is to restore dollar and gold convertability.

About Me

Larry Kudlow

Lawrence Kudlow is CNBC’s Senior Contributor. For many years, he was the host of CNBC’s “The Kudlow Report”. He is also the host of The Larry Kudlow Show, which broadcasts on Saturdays from 10am to 1pm ET on WABC Radio and is syndicated nationally by Cumulus Media. He is also a nationally syndicated columnist and a former Reagan economic advisor. CNBC's The Kudlow Report also airs on Sirius (ch.129) and XM (ch.127) weeknights at 7pm ET.